After Arthur Levitt's speech on market structure Thursday night, it seems sure the
Securities and Exchange Commission
chairman wants to take the wrecking ball of competition to the nation's financial markets. But no one, including Levitt, is sure what will emerge from the rubble.
Continuing on a
theme that's been the agency's focus for the past two years, Levitt peppered his speech to the overflow crowd at
with loaded phrases, such as "entrenched interests" and "parochial," directed at the exchange community. At the same time, the SEC chief praised what he called the dynamic qualities of the electronic communication networks that have proliferated in recent years, threatening to swing the balance of power in the securities markets.
Yet for all of Levitt's focus on competition, many pros remain concerned with the market's integrity during what will continue to be a revolutionary transformation.
By opening this debate, Levitt has "unleashed the dogs of war and now he has got to think of a way to solve this problem," says Howard Schwartz, chairman of broker/dealer firm
Lynch Jones & Ryan
. "Competition doesn't provide regulation -- it actually may force rivals to find ways to circumvent regulations."
Fragmentation of the markets and price disparities among the different platforms is a major concern. "If under increased competition the result is a market where there are 10 different marketplaces and 10 different prices, then you'd have to start worrying about transparency and liquidity," Schwartz says.
Levitt is concerned, too, and is pinning his solution on further connectivity between ECNs and the exchanges to vanquish the twin bogeymen of fragmentation and illiquidity. Levitt laid out plans for a "virtual limit order book," an electronic poster board of limit orders and quotes that could go a long way to ensuring investors of the best possible price.
Levitt may try to address the fragmentation issue by focusing on ECN access fees. In his speech, he said the fees, now charged to any broker-dealer using an ECN to complete a trade, need to be "redressed."
Cameron Smith, general counsel for the
ECN, likes Levitt's vision of creating competition between markets, including trading listed stocks of the NYSE. "We think anything that could open the market to competition is good for Island," he says, pointing to the fact that Island charges less than some of the other ECNs.
Not all ECNs believe that you should be able to charge those access fees in the first place. Arthur Pacheco, president and chief executive of
, said that his ECN (one of the smaller ones) charges its customers for representing them in the market but doesn't garner revenue from parties they might end up trading with.
"Market makers have an obligation to maintain markets," he explains, "and they have an obligation in terms of best execution, which is driven by a net price that is displayed -- but that's a false price," because they're not figuring in the access fees.
Overall, however, if Levitt's speech means the SEC is aware that there are radical changes ahead for the industry, then upstart ECN operators may sum up their feelings in one word: "Finally."
Harvey Houtkin, president of
All-Tech Investment Group
ECN, has assaulted the establishment since he became one of the original SOES (small-order execution system) bandits who drove the
stock market to an overhaul. He says he feels vindicated.
Houtkin says that "a certain elite group" on Wall Street had used its influence with the SEC and the government to keep the stock market from becoming a central electronic one, as it has in some European and Asian countries. And if the SEC's plan is to allow listed stocks to be traded on any exchange, Houtkin says he thinks the electronic method will dominate if the traditional market-making system and the electronic communications networks are on a level playing field. "It'll make ECNs much more competitive and viable," he says.
What the SEC is envisioning is one big liquidity pool of trading orders that will go where the hand of the market dictates -- naturally, toward the best price, says Robert Wood, professor of finance at
Fogelman College of Business
University of Memphis
. And the
New York Stock Exchange
, which has remained steadfast for most of the last two centuries, is sitting right in the crosshairs of the SEC vision of the future.
Wood says he doubts the NYSE's argument -- that its own centralized order flow, system of market specialists and separate regulatory organ is the best way to ensure an efficient market and avoid fragmentation. "If centralized order flow
at the NYSE is so good, then why all the
alternative trading systems? And why is no one on the NYSE selling their seats? They are making excess profits, that's why," he says.
The NYSE is continuing to work with the SEC to keep the exchange a "model for the world," the exchange stated in a brief press release response to Levitt's speech.
And all this rush to competition has the establishment trying to break from their not-for-profit shackles, a point of contention from the Canyon of Heroes to market-maker central in Jersey City.
"The SEC should be poking around figuring out what the consequences are going to be," says Emanuel "Buzzy" Geduld, president and chief executive of the Nasdaq market maker
Herzog Heine & Geduld
. Going public, he said, raises questions about what will happen if the exchange ends up being owned by only a few shareholders.
Levitt has said, and reiterated Thursday night, that the SEC has concerns about IPOs in the future of the NYSE or Nasdaq -- specifically, the conflict of self-regulating a now profit-driven company. The SEC is looking at a number of options, including a single regulatory body to oversee all the markets.
Wood argues that if Levitt is so high on pricing competition, then why not seek regulatory competition too? "Trying to force things to centralize is a mistake," says Wood. "We think such a thing will have economies of scale, but what we end up with is an inefficient, bloated bureaucracy that isn't responsive to anybody."